RGA - Reinsurance Group of America: Undervalued Wealth Compounder

2023-08-01 11:39:28 ET

Summary

• Reinsurance Group of America offers a higher yield and faster dividend growth rate compared to the S&P 500.
• It has a long operating history that dates back 5 decades and has more than doubled its book value over the past 10 years.
• RGA is well-positioned to benefit from higher interest rates and increased deal activity in the commercial mortgage space.

It pays to have a basket of strong income generators, and not all the payers need to be high yield. For example, some may want to build an income ladder that includes lower-yielding but faster-growing names. This can lead to an overall average income growth rate that meets or exceeds the rate of inflation.

This brings me to Reinsurance Group of America ( RGA ) which supports a yield that's higher than the S&P 500 ( SPY ) and carries a faster dividend growth rate. It's been a while since I last looked at RGA here since early 2021, highlighting how it's positioned to benefit from rising rates.

The stock has responded well, giving investors a 30% total return over this timeframe, far surpassing the 20% rise in the S&P 500. In this article, I discuss recent developments and provide an updated valuation and recommendation.

Why RGA?

Reinsurance Group of America is a global company that focuses on life and health reinsurance solutions. It has a long operating history dating back 50 years, and today, has $3.4 trillion of life reinsurance in force and assets of $89 billion. RGA's total returns over the past 10 years also outperformed the S&P 500 over much of the time until recent years, as shown below, but I think that has more to do with undervaluation (more on that later).

Like all insurance companies, the goal for RGA is to invest its excess premiums over insurance payouts in order to generate risk-adjusted returns for shareholders. RGA has been able to achieve this through balanced capital management over the past 15 years. This includes book value per share (excluding accumulated other comprehensive income) more than double over the past 10 years alone, as shown below.

RGA has been able to continue its value creation this year, by growing premiums by 10.8% YoY on a constant currency basis during the first quarter. It also achieved a healthy ROE excluding one-time items of 13.% over the trailing 12 reported months. This enabled RGA to grow its business by deploying $194 million into in-force insurance policies across North America, Europe, and Asia.

As an insurer, RGA is also largely benefiting from higher interest rates through its investments. This is reflected by the interest rate on new money invested growing by 175 basis points to 5.56% in the last reported quarter. RGA also adopts a disciplined investment approach with an emphasis on higher quality, diversified fixed income assets. This is reflected by over 94% of its fixed income securities being investment grade rated, and 63% are A/AA/AAA credit rated.

It's worth noting that RGA also invests in commercial mortgage loans with a $6.9 billion carrying balance. While this segment carries more risk, management adopts a more conservative approach, as reflected by average loan to value of 56%. This sits lower than the ~65% for commercial mortgage REITs such as Ladder Capital ( LADR ) and Starwood Property Trust ( STWD ) and helps to reduce the risk of a default due to borrowers having significant skin in the game.

The debt service coverage ratio of this portfolio also sits above 1.8x on average. As shown below, retail, office, industrial, and multi-family property types make up the four largest real estate collateral segments. Notably, the office portfolio is made up of suburban offices, which are not experiencing the same level of hybrid and remote work that urban offices are facing due to long commute times.

Looking ahead, I'd expect for RGA to continue to generate solid returns on equity as interest rates remain elevated for the foreseeable future, especially after the Federal Reserve raised rates again by 25 basis points in July. RGA could also be benefiting from increased deal activity in the commercial mortgage space, as regional banks pull back due to capital considerations.

Meanwhile, RGA carries a strong balance sheet with a long-term debt to capital of 37% and an 'A' credit rating from S&P. It also has excess capital of $1.4 billion, which acts as a safety buffer. RGA currently yields 2.3%, and the dividend is well-protected by a low 16% payout ratio and comes with a 5-year CAGR of 9.9% and 14 years of consecutive growth. This compares favorably to the 1.4% yield of the S&P 500 and its 5.8% 5-year CAGR.

Risks to RGA include, of course, catastrophic events that might impact human health and lives. Also, materially lower interest rates would impact its bottom line profitability.

Lastly, RGA remains an attractive value stock at the current price of $140 with a forward PE of 8.0x, sitting well below its normal PE of 11.2. This is also considering the 3% EPS growth next year and 8-9% annual EPS growth thereafter expected by analysts who follow the company. RGA could give shareholders meaningful returns should it return to just 10x PE, which appears reasonable.

Investor Takeaway

Reinsurance Group of America has managed to achieve solid returns for shareholders over the past 10 years, despite plenty of ups and downs for the market and the overall economy during that time. It's also well-positioned to benefit from higher interest rates and increased deal activity in the commercial mortgage space as regional banks pull back. With a strong balance sheet and low payout ratio, RGA offers investors an attractive yield with potential for dividend growth that outpaces inflation and that of the S&P 500. As such, investors seeking a well-rounded pick for potentially strong total returns may want to consider RGA.

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